Alternative Markets Update End-June 2021

​Inflation has been among the most important concerns in 2021, after the world has been able to fight the virus to some degree after over a year and a variety of vaccines. The inflation concerns stem from two main sources, the increased liquidity provided from central bank interventions through quantitative easing and the stimulus packages from governments. These two major components are shown in Figures 1 and 2. The first figure shows the balance sheet of the federal reserve. Since Covid-19, the balance sheet has doubled to $8tn. Despite the increase being smaller on a relative basis compared to the global financial crisis, the absolute terms differ vastly. While during the global financial crisis in 2008, the balance sheet grew from $1tn to $2tn, which was seen as unprecedented and extremely large intervention, it is only a quarter of the interventions following the occurrence of Covid-19 in early 2020. This has several implications. It will substantially increase the liquidity provided to the financial market and if the balance sheet is reduced, it will likely cause more volatility, as it was the case at the end of 2018 when equity markets decreased substantially. This is under the assumption that Covid-19 is now and will remain at a stage it can be handled. The entire underlying assumption could change, if, for example, a new strain of Covid-19 would emerge that is resistant to the currently available vaccinations. Figure 2 shows the government stimulus packages provided to fight the economic impact of Covid-19, which has surpassed $10tn globally. Again, this provides additional liquidity to financial markets and there has not been a large wave of defaults, due to government guarantees and similar programs. It remains to be seen, how this evolves, once the government guarantees are withdrawn, which could trigger additional volatility in the market. These two indicators suggest that inflation is very likely to increase in the short-term with potentially long-term consequences. Furthermore, instead of only anticipating rising inflation, it started to effectively to show, as the US inflation rate in May has risen to 5% compared to only 1.4% in January 2021 and BoE’s Haldane has warns that inflation is expected to rise close to 4% in 2021. Figure 3 looks at inflation in recent years for selected US consumer goods and services, which have developed vastly different, even when disregarding the impact of Covid-19. For example, within the last twenty years, hospital services have doubled, whereas TVs have decreased by 90%. The overall inflation over this time frame was almost 55%. It seems to be the case that most industries that are substantially affected by the government have increased massively, whereas fewer regulatory inventions have led to decreasing prices of goods and services. However, this is not entirely objective, as three out of the four massively more affordable goods are tech related. For technological products and services, it is common that they are very expensive in the beginning but lose value very quickly and become cheap and widely accessible. In an environment, in which inflation is a huge concern, equities seem like a good way to hedge some of the inflation risk. But, its attractivity is limited, as stock markets have risen incredibly since the initial drawdown caused by Covid-19. The S&P 500, for example, is almost breaking its high on a daily basis with a high of 4,302 (as of 1st July 2021). This boom in the stock market, alongside the surge in valuations of mostly technology companies, has led to 5.2m new millionaires in 2020, as shown in Figure 4. Consequentially, equity hedge funds have done mostly very well last year, some (for example Long/Short US Equity Consumer, TMT, Healthcare) being up more than 60% in 2020. In 2021, the growth has slowed down, as our SMC Equity Strategy Index is up almost 6% as of May 2021. The best performing equity strategy is Equities US Activist Event Driven with a YTD of 26% in 2021.

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RESEARCH PERSPECTIVE VOL. 158 June 2021 Alternative Markets Update June 2021 Inflation has been among the most important concerns in 2021, after the world has been able to fight the virus to some degree after over a year and a variety of vaccines. The inflation concerns stem from two main sources, the increased liquidity provided from central bank interventions through quantitative easing and the stimulus packages from governments. These two major components are shown in Figures 1 and 2. The first figure shows the balance sheet of the federal reserve. Since Covid-19, the balance sheet has doubled to $8tn. Despite the increase being smaller on a relative basis compared to the global financial crisis, the absolute terms differ vastly. While during the global financial crisis in 2008, the balance sheet grew from $1tn to $2tn, which was seen as unprecedented and extremely large intervention, it is only a quarter of the interventions following the occurrence of Covid-19 in early 2020. This has several implications. It will substantially increase the liquidity provided to the financial market and if the balance sheet is reduced, it will likely cause more volatility, as it was the case at the end of 2018 when equity markets decreased substantially. This is under the assumption that Covid-19 is now and will remain at a stage it can be handled. The entire underlying assumption could change, if, for example, a new strain of Covid-19 would emerge that is resistant to the currently available vaccinations. Figure 2 shows the government stimulus packages provided to fight the economic impact of Covid-19, which has surpassed $10tn globally. Again, this provides additional liquidity to financial markets and there has not been a large wave of defaults, due to government guarantees and similar programs. It remains to be seen, how this evolves, once the government guarantees are withdrawn, which could trigger additional volatility in the market. These two indicators suggest that inflation is very likely to increase in the short-term with potentially long-term consequences. Furthermore, instead of only anticipating rising inflation, it started to effectively to show, as the US inflation rate in May has risen to 5% compared to only 1.4% in January 2021 and BoE’s Haldane has warns that inflation is expected to rise close to 4% in 2021. Figure 3 looks at inflation in recent years for selected US consumer goods and services, which have developed vastly different, even when disregarding the impact of Covid-19. For example, within the last twenty years, hospital services have doubled, whereas TVs have decreased by 90%. The overall inflation over this time frame was almost 55%. It seems to be the case that most industries that are substantially affected by the government have increased massively, whereas fewer regulatory inventions have led to decreasing prices of goods and services. However, this is not entirely objective, as three out of the four massively more affordable goods are tech related. For technological products and services, it is common that they are very expensive in the beginning but lose value very quickly and become cheap and widely accessible. In an environment, in which inflation is a huge concern, equities seem like a good way to hedge some of the inflation risk. But, its attractivity is limited, as stock markets have risen incredibly since the initial drawdown caused by Covid-19. The S&P 500, for example, is almost breaking its high on a daily basis with a high of 4,302 (as of 1st July 2021). This boom in the stock market, alongside the surge in valuations of mostly technology companies, has led to 5.2m new millionaires in 2020, as shown in Figure 4. Consequentially, equity hedge funds have done mostly very well last year, some (for example Long/Short US Equity Consumer, TMT, Healthcare) being up more than 60% in 2020. In 2021, the growth has slowed down, as our SMC Equity Strategy Index is up almost 6% as of May 2021. The best performing equity strategy is Equities US Activist Event Driven with a YTD of 26% in 2021. Figure 1: Federal Reserve Balance Sheet and Percentage YoY Change, Source: FRED St. Louis, June 2021 Figure 2: Global Government Stimulus Response related to Covid-10 Crisis, Source: WHO, June 2021 Figure 3: Price Changes in Selected US Consumer Goods, Services and Wages, Source: Kraken, BLS & Mark Perry (American Entreprise Institute), June 2021 Figure 4: Adults with Wealth Above $1m in 2019 and 2020, Source: Credit Suisse Global Wealth Databook 2021 Other options that are viable to offset inflation risk to some degree are commodities and cryptocurrencies. Gold had a very strong return after its initial drawdown in March 2020 to $1,500 per ounce to almost $2,100 in August 2020. Since then, it has declined consistently and bottomed at $1,700 in March 2021. Afterwards, it has risen back to $1,900 and fell again to below $1,800 during May and June 2021. Another commodity, oil, has done substantially better than gold over the past year, despite its futures dropping to negative values in April 2020. For most of 2020, WTI crude oil remained around the $40 mark, before starting its bull run in early November 2020. Thereafter, it continuously increased and is currently trading at $76 per barrel. Another attractive strategy in this area is Discretionary Global Macro, which is up 53.90% YTD in 2021. However, when comparing these traditional assets at the beginning of 2020 with cryptocurrencies, their returns are mediocre, as Figure 5 shows. When taking values prior to the Covid-19 crisis, the returns of all previously discussed assets are substantially lower, despite equities still being up 32% in 1.5 years. In spite of the recent substantial drawdown of cryptocurrencies, they still by far outperform traditional assets, as Bitcoin (BTC) is up 375%, which is a relatively low percentage compared to other existing coins. Ethereum (ETH), the second largest cryptocurrency, is up a staggering 1,449%, although it is still down more than 50% from its previous high of $4,300 in April 2021. Other interesting application of cryptocurrencies focus on areas in decentralized finance (DeFi), stablecoins or infrastructure of the ecosystem. Polkadot (DOT), for example, is a project that focuses on the interoperability of different cryptocurrencies. Many other coins focus on DeFi, such as Uniswap, which is the largest decentralized exchange for cryptocurrencies, or Maker, that runs an ecosystem for a stablecoin (DAI), a cryptocurrency that is pegged to the US-Dollar. Since the drawdown of cryptocurrencies in May 2021, the attractiveness of the space has decreased significantly, as BTC, typically the most resilient currency in the space, lost more than 55% within days. Many other cryptocurrencies have lost substantially more. However, when looking at historical drawdowns of BTC, the most recent one was nothing special or unprecedented, as shown in Figure 6. When BTC was emerging, there were multiple drawdowns over 90%, and in 2017, the drawdown was 84%. This reaction was mostly caused by the recent news on China banning and crucially executing the ban on crypto mining and its use in business transactions. This is nothing new, as China has banned BTC and other cryptocurrencies in 2013 and 2017 already. After each of those bans, BTC gained significantly as shown in Figure 7. If one considers BTC and other crypto assets as disruptive technology “stocks” or “businesses”, it is not different to the ban of Twitter, Facebook etc. in China. Those bannings gave rise to Chinese equivalents being built, which count towards the largest companies in the world. The case for BTC does not seem to be different, as China is committed to launch its own cryptocurrency, in which case a banning of BTC makes sense from the historical pattern observed so far. Despite those recent development, cryptocurrency-based strategies still have a stellar 2021 so far, as the two best performing strategies as of May 2021, Token Liquid and Token, are up 250% and 205%, even though they experienced a drop of 30% or more in May 2021. Figure 5: Performance Comparison of Selected Crypto Assets and Traditional Assets from January 2020 until June 2021, Source: June 2021, Pantera Capital Figure 6: Major Correction of Bitcoin from All-Time Highs from September 2010 until June 2021, Source: Coumpound & CoinDesk, June 2021 Figure 7: Returns of Companies & Bitcoin after Banning from China, Source: June 2021, Pantera Capital STONE MOUNTAIN CAPITAL Stone Mountain Capital is an advisory boutique established in 2012 and headquartered in London with offices Pfaeffikon in Switzerland, Dubai and Umm Al Quwain in United Arab Emirates. We are advising 30+ best in class single hedge fund and multi-strategy managers across equity, credit, and tactical trading (global macro, CTAs and volatility). 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